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A Roth IRA Can Be a Good Estate Planning Tool

The potential benefits of a Roth individual retirement account (IRA) as a retirement savings plan are well known -- tax-free distribution of plan assets and no requirement to begin taking withdrawals no matter your age. However, many people may be unaware of how a Roth IRA can be an effective estate planning tool in certain circumstances.

How a Roth IRA Works

Contributions to a Roth IRA are non-deductible and investment earnings accumulate tax deferred. Withdrawals from a Roth IRA (including earnings) are tax free once you reach age 59½ (and in certain other circumstances), provided the withdrawal is made after the five-tax-year period that begins with the first tax year for which the first Roth IRA contribution was made. As a result, a Roth IRA can be a source of tax-free income.

Perhaps more important from an estate planning perspective is that, unlike with a traditional IRA, there's no obligation to take annual required minimum distributions (RMDs) from your Roth account after age 72. Although account beneficiaries are subject to RMD rules, they won't have to pay income taxes on their withdrawals (assuming the five-year holding period has been met).

The Roth IRA as an Inherited Asset

The RMD rules depend on who inherits your account. If you name your spouse as the beneficiary of the Roth IRA, your spouse can choose to put the Roth IRA in his or her name. As the account owner, your spouse would not have to take RMDs, providing an opportunity for the account to continue growing tax free while your spouse is living.

The rules are different if you name a child, grandchild, or other individual as the beneficiary of your Roth IRA. The SECURE Act eliminated what was known as the "stretch" IRA for most non-spousal beneficiaries. Under the changed regulations, a non-spousal individual beneficiary is required to withdraw all assets in the Roth IRA within 10 years of the owner's death and, depending on the owner's age, may have to take annual RMDs in years one through nine. There are exceptions to the 10-year rule for beneficiaries who are:

  • Disabled or chronically ill;
  • Not more than 10 years younger than the owner of the Roth account; or
  • Minor children. However, the child has 10 years to withdraw money from the Roth account after the child attains the age of majority.

The Advantages of Using a Roth IRA

A Roth IRA may be a useful addition to your overall financial and estate plan. If you have retirement funds in a traditional IRA or a 401(k) plan, a Roth IRA provides tax diversification. It gives you the ability to withdraw funds on a tax-free basis, which, in turn, provides tax planning options when the future direction of tax rates is unclear. Your Roth IRA can also be a source of nontaxable income for your beneficiary after your death.

Although converting funds in a traditional IRA to a Roth IRA is a taxable event, a conversion can be a good planning strategy in the right circumstances. Consult with your financial and tax professionals for assistance in determining whether it may be worthwhile to incorporate a Roth IRA into your planning.